Table of contents
- Salient features
- How to understand futures better?
- How to understand options better?
- Is trading in futures and options always profitable?
- How does the contract execution of futures and options go on?
- What about advance payment?
- What are the similarities between futures and options?
- Which one is relatively inexpensive?
- Which one is safer?
- Taxation of future and options
- Bottom line
- FAQs
Futures vs Options: Know the key difference! What type of trade would suit your trading risk appetite?
Futures and options are powerful financial tools used by thousands of investors. They hedge and assist traders profit from equity and commodity price volatility. The main distinction is that Options let you acquire underlying assets.
Futures require investors to buy the asset within a certain timeframe. Which instrument meets your trading risk appetite depends on this minor variation.
Salient features
Futures:
They experience limited price change, can sometimes fall to $0, and define the present market price of a future underlying asset.
Options:
As a contract holder, you’re not obligated to purchase an underlying asset, the contract predetermines future investment price, the option’s intrinsic value can’t go below $0, and its value, tied to the underlying asset, lessens over time.
How to understand futures better?
When buying futures contracts, you need not stake the full value. You only need a small percentage of the investment’s initial margin.
The contract’s value will certainly change. When you lose a lot, your broker may ask for a deposit. Before stock expiration, most commodities traders close their positions.
Sell such contracts and you may obtain enough money to cover your margin loan. This should yield profits even when asset values fall.
How to understand options better?
Option contracts don’t require you to sell your underlying assets. You should know that options have calls and puts.
- Calls: It lets investors acquire any asset at a pre-set rate on a specific date. The word ‘choice’ means you can choose to receive these items.
- Puts: Contract holders can sell underlying assets here. Making it is optional.
A basic Option stock may link to 100s of shares of any underlying stock since an underlying asset might be stock, bond, or futures. Options and futures use the same commodities futures units.
Call investments are like betting on the underlying assets. This may or may not lower prices. Put bets never lower the price.
Futures and options example
Futures: You agree to buy 100 shares at $50 each in 3 months;
Options: You have the right to buy 100 shares at $50 each in 3 months, but you’re not obligated to.
Is trading in futures and options always profitable?
When considering future and options trading, note that futures can generate endless gains and losses. Options can swing between incomprehensible loss and profit. It protects against extreme loss.
How does the contract execution of futures and options go on?
This is another key difference between futures and options. Futures contracts must be executed on the agreed-upon date. On that date, you must buy the asset regardless of market value.
Options allow buyers to execute contracts almost anytime before they expire. Therefore, you can acquire the asset at any favourable time.
What about advance payment?
No upfront cost is required to enter the Futures contract. Buyers must pay the predetermined asset price.
Options Contract trading requires a premium. Your obligation to buy the asset at a scheduled date would be avoided with this payment. You can take your time till the market recovers.
What are the similarities between futures and options?
Futures and options trading require margin accounts. It includes the Insurance Regulatory Authority. However, a third-party authorisation is necessary. Retail traders need brokerage accounts and margins. This can help protect retirement investments from trade risks like Options and Futures.
Like many other enthusiastic traders, you might wonder what the difference is between futures and options. Well, here are the chief takeaways:
- Contract dates affect trading. Options let you trade anytime before expiration, but futures contracts do not.
- Sellers of Futures contracts before expiration usually lose their trades. Options eliminate exercise. Even with little effort or business, it may expire cheaply. Premiums may be the only cost.
Which one is relatively inexpensive?
Futures’ business volume is massive. They require little margin or upfront cash. Purchase options contracts, however, and pay your writer a premium. This amount depends on your traders’ market forecast and the asset’s spot price.
Futures usually cost less than options. But Futures margin requirements can be substantial. It can be 3–12% of trading volume.
Which one is safer?
Both these trading options have their share of risks. You have to exercise options contracts on time. Otherwise, it can lose its value fast. This can pave the way to a total loss. However, as an individual investor, you might get exposed to bigger threats while trading in Futures.
Taxation of future and options
Futures and options are taxed under the Income Tax Act as business income. Profits are taxed as per the applicable slab rate, while losses can be offset against income from other heads.
Required turnover for futures and options
If the turnover exceeds Rs. 2 Cr or there’s a loss, a tax audit may be required.
Bottom line
Hopefully, you now have some clarifications regarding “what are futures and options?” Now that you can analyse the main differences between these two forms of trading, you can make your decisions more confidently than before.
As an investor, it always helps to gather as much information as possible before taking a plunge.
FAQs
Yes, futures contracts can be sold before their expiry. These contracts are highly liquid and can be traded during the exchange’s trading hours. This flexibility allows traders to exit their positions before the contract’s expiration if they choose to do so. Alternatively, a trader can buy another futures contract that cancels out the original one, effectively nullifying the first contract.
The Islamic perspective on Futures and Options (F&O) trading is complex. Some scholars argue it’s halal (permissible) due to minimal uncertainty in regulated markets, its hedging nature, and its ethical intention. However, others consider it haram (prohibited) due to excessive uncertainty (Gharar), the potential for manipulation, and the resemblance to gambling. It’s best to consult with a knowledgeable Islamic scholar for personalised advice.
Yes, Futures and Options (F&O) trading is taxable in India. The income from F&O trading is treated as non-speculative business income. It should be reported under the Profits & Gains from Business and Profession (PGBP) head while filing income tax returns. The tax rate depends on the individual’s income slab.
Yes, it is compulsory to file an Income Tax Return (ITR) for intraday trading in India. The income from intraday trading is considered speculative business income. Since intraday trading is a business income, traders must file ITR-3 and prepare financial statements. It’s important to accurately report the income from intraday trading to ensure compliance with tax laws.
Taxes on transactions from a demat account are not automatically deducted. When shares or other securities are sold, capital gains tax is levied based on the holding period. However, the Securities Transaction Tax (STT) is imposed on both buyers and sellers in the Indian stock market and is reflected in the contract notes provided by the broker. It’s important to consult with a tax advisor for personalised advice.